Determinants of Interna:onal Economic Growth. Professor George Alogoskoufis Fletcher School, TuCs University

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1 Determinants of Interna:onal Economic Growth Professor George Alogoskoufis Fletcher School, TuCs University

2 The Measurement of Economic Growth Living standards are usually measured by annual Gross Na:onal Income (GNI) per capita, or annual Gross Domes:c Product (GDP) per capita. However, in order to perform cross country comparisons, per capita income must be measured in comparable units. This requires the transforma:on of per capita income in a common currency, usually the US dollar. In order to adjust for differences in purchasing power among countries, we use exchange rates that reflect differences in purchasing power. These exchange rates ensure purchasing power parity (PPP), and are called PPP adjusted exchange rates. Thus, for all countries, GNI per capita, or GDP per capita is measured in PPP adjusted dollars, or interna:onal dollars. For comparisons over :me, we also adjust for infla:on in each country, using real per capita income or output. 2

3 Data and Methodology of Measuring per capita GNI and GDP For the exact methodology of measuring per capita GNI and GDP see the World Bank, Summers and Heston (1991), who have calculated comparable data for many countries since 1950, or Maddison (1982), who has calculated comparable data since 1A.D. World Bank data, the data of the Penn World Tables (which are based on the Summers and Heston methodology), and the data of the Maddison Project (based on the Maddison methodology) are revised at regular intervals. For the Maddison Project see Bolt and van Zanden (2014). 3

4 Cross Country Differences in Per Capita Output and Income The World Bank publishes comparable data, in interna:onal US dollars, measuring the per capita Gross Na:onal Income (GNI) of 214 countries of the world. For 2012 the relevant data existed for 184 countries. The average per capita GNI of countries classified as high income economies was $39,903, while the average per capita GNI of low income economies was $1,870. The per capita income of high income (developed) economies was thus on average 20 'mes higher than that of low income, or least-developed economies. The average per capita income of middle income economies was equal to $9,075. The per capita income of high income (developed) economies is thus on average 4 :mes higher than that of middle income economies. For example, in the USA, annual per capita Gross Na:onal Income (GNI) in 2012 was $52,220, while the annual per capita income of the Congo, one of the poorest economies, was only $710, of comparable purchasing power. The Congo had a per capita income which was just 1.4% of the US per capita income. 4

5 Distribu:on of Countries by per capita GNI, " 90" 80" 70" 60" 50" 40" 30" 20" 10" 0" $0"to"$1000" $1000"to"$10000" $10000"to"$20000" 20000"to"$30000" $30000"to"$40000" $40000"to"$50000" Greater"than"$60000" Number"of"Countries" 5

6 Distribu:on of Countries by per capita GNI, 2012 Five countries (Qatar, Macau, Singapore, Bermuda and Norway) had GNI per capita above $60,000. Seven countries (United Arab Emirates, Luxembourg, Switzerland, Saudi Arabia, Oman, the USA and Hong Kong) had GNI per capita between $50,000 and $60,000. Eight developed European economies, as well as Australia and Canada, had GNI per capita between $40,000 and $50,000. Twelve countries (including France, Great Britain, Japan, Italy, N. Korea, Spain, New Zealand and Israel) had GNI per capita between $30,000 and $40,000. Twenty-two countries (including Greece, Cyprus, and Russia) had GNI per capita between $20,000 and $30,000. Forty countries (including Turkey, Brazil and China) had GNI per capita between $10,000 and $20,000. Ninety countries, about half of the 184, had a GNI per capita between $1,000 and $10,000. These included India, with per capita GNI of $5,080. Finally, six countries in sub-saharan Africa, had per capita GNI of less than $1,000. 6

7 Economic Growth in Historical Perspec:ve Before 1820, available data on the per capita output and income of various countries, and their growth rates, is extremely rare. The es:mates of Maddison (1982) suggest that the average growth rate of real world GDP per capita in the period was only 0.04% per year, while in the period just 0.07% per year. Even in Western Europe, for which the period was one of great economic prosperity compared to other world regions, the average growth rate of GDP per capita did not exceed 0.14% per annum. Before 1500, all indica:ons suggest that the standard of living, despite large cyclical fluctua:ons, showed no long-term trend. A second feature of this period was that income differences between countries were very small compared to today. According to es:mates of Bairoch (1993), the differences in living standards between the richest and the poorest countries did not exceed to 1. Moreover, Bairoch es:mates that there were no significant differences in living standards between Rome in the 1st century AD, the Arab caliphates in the 10th century AD, China in the 11th century, India on the 17th and Europe in the early 18th century. 7

8 Europe versus the Rest of the World In the 15th century AD, before the major economic boom in Europe, China, the Ojoman Empire, the Incas and the Aztecs seem to have had a higher standard of living than Western Europe. However, economic growth in Western Europe picked up acer 1500 AD. A drama:c case of rela:ve economic decline was that of China. Between the 8th and the 12th century, China experienced a unprecedented period of economic and cultural prosperity. It was in this period that gunpowder, prin:ng and the hydraulic hose reel were invented. Coal was used in the produc:on of steel and a series of canals and waterways for water supply and transporta:on of products was constructed. The magne:c compass was invented in that period, and the imperial fleet of China had reached as far as the eastern coast of Africa by the early 15th century. However, China gradually withdrew from the world economy, following a policy of introversion, and around 1750 the standard of living in Europe had overtaken the Chinese standard of living. One hundred years later, in the 19th century, China was unable to defend itself during the opium wars against Great Britain, and in the 20th century it was one of the least developed economies of the world. 8

9 The Ships of Zeng He versus the Caravelle of Christopher Columbus 9

10 The Evolu:on of per capita Output and Income since 1820 The average growth rate of world per capita output increased between 1820 and 1870, reaching 0.5% per year. Between 1870 and 1950 the average growth rate doubled to 1.1%, and since 1950 it doubled again to over 2%. Between 1950 and the early twenty-first century, many countries have seen their standard of living to more than triple. As a result, in the high income countries, real per capita output and income today is, depending on the country, between 10 and 30 :mes higher than it was two hundred years ago. However, the growth process has not been uniform. In 1820, the more developed countries had a per capita GDP which was about three :mes the per capita GDP of less developed countries. In 2012, it was about twenty (20) :mes higher. The former colonies of Western Europe (USA, Canada, Australia and New Zealand) in 1820 had a slightly lower standard of living compared to Western Europe itself. In 1950 they had twice the per capita income of Western Europe. Japan surpassed the standard of living of Eastern Europe, La:n America, the former Soviet Union and Western Europe in the second half of the 20th century. China, one of the poorest countries in the world in 1950, in 2010 had a per capita income which was more than double the per capita income of India and Africa. La:n America, parts of Asia and Africa have been lec behind. 10

11 How Long does it take for per capita GNI or GDP to double? The number of years required for a magnitude like per capita output or income to double in value depends on its growth rate. If per capita real income grows at g% per annum, it takes approximately 70/g years for it to double. Thus, if g is 1%, it takes 70 years for per capita real income to double, if g is 2% it takes 35 years for it to double, if g is 3% it takes 23 years, and so on. This rule of 70 is derived from 100xln2=69.3, which is approximately equal to

12 Real GDP per capita in Great Britain, the USA and Japan since $ 10.50$ 10.00$ 9.50$ 9.00$ 8.50$ 8.00$ 7.50$ 7.00$ 6.50$ 6.00$ 1800$ 1804$ 1808$ 1812$ 1816$ 1820$ 1824$ 1828$ 1832$ 1836$ 1840$ 1844$ 1848$ 1852$ 1856$ 1860$ 1864$ 1868$ 1872$ 1876$ 1880$ 1884$ 1888$ 1892$ 1896$ 1900$ 1904$ 1908$ 1912$ 1916$ 1920$ 1924$ 1928$ 1932$ 1936$ 1940$ 1944$ 1948$ 1952$ 1956$ 1960$ 1964$ 1968$ 1972$ 1976$ 1980$ 1984$ 1988$ 1992$ 1996$ 2000$ 2004$ 2008$ GB/UK$ USA$ Japan$ 12

13 Real GDP per capita in Great Britain, the USA and Japan since 1800 In 1800, Bri:sh per capita GDP was more than 60% higher than in the USA. At the beginning of the 20th century, per capita GDP in the USA had surpassed the corresponding Bri:sh one, because of the higher growth rate in the USA. The two World Wars led to a widening of the gap between the USA and Britain, despite the fact that the Great Depression of the 1930s was more severe in the USA. ACer the Second World War, per capita output in the USA has remained consistently higher than in Britain and the other main developed economies. The Japanese GDP per capita, for which con:nuous annual es:mates exist only acer 1870, has been consistently lower than the Bri:sh and American one in the 19th century. In 1870, it was only 23% of the corresponding Bri:sh one, and only 30% of the American one. By 1913, on the eve of World War I, it had risen to 28% of the Bri:sh per capita GDP, but had fallen to 26% of the American one. Japan had experienced slightly higher growth than Britain, but lower growth that the USA. By 1939, on the eve of World War II, GDP per capita in Japan had risen to 45% of the corresponding one in Britain, and to 43% of the corresponding one in the USA. Japan experienced much higher growth than Britain and the USA during World War I and the interwar years. Japanese per capita output fell precipitously in the acermath of World War II, much more than in Britain and the USA. However, since the end of the World War II, Japan has experienced very high growth, and by the mid-1970s the Japanese GDP per capita had converged to the Bri:sh one. Since the early 1980s, Japanese growth slowed down, and Bri:sh growth picked up, with the result that Britain has again surpassed the living standards of Japan. 13

14 Real GDP per capita in the Four Major European Economies since $ 10.00$ 9.50$ 9.00$ 8.50$ 8.00$ 7.50$ 7.00$ 6.50$ 6.00$ 1800$ 1804$ 1808$ 1812$ 1816$ 1820$ 1824$ 1828$ 1832$ 1836$ 1840$ 1844$ 1848$ 1852$ 1856$ 1860$ 1864$ 1868$ 1872$ 1876$ 1880$ 1884$ 1888$ 1892$ 1896$ 1900$ 1904$ 1908$ 1912$ 1916$ 1920$ 1924$ 1928$ 1932$ 1936$ 1940$ 1944$ 1948$ 1952$ 1956$ 1960$ 1964$ 1968$ 1972$ 1976$ 1980$ 1984$ 1988$ 1992$ 1996$ 2000$ 2004$ 2008$ GB/UK$ France$ Germany$ Italy$ 14

15 Real GDP per capita in the Four Major European Economies since 1800 France, Germany and Italy had significantly lower per capita GDP than Britain throughout the 19th century and the first half of the 20th century. For France and Germany there was a slow process of convergence un:l the eve of World War I, and faster convergence in the interwar period. In the acermath of World War II, convergence was rapid, and by the early 1970s, per capita GDP did not differ by much in these four economies. 15

16 Economic Growth since 1950 There has been a significant increase of world economic growth in the postwar period. Between 1950 and 2010, i.e during the last 60 years, the real per capita GDP of the USA more than tripled. Its average annual growth rate was about 2% per annum. The major developed European economies displayed even higher growth. The average annual growth rates of real per capita GDP in Britain was 2.1%, slightly higher than in the USA. Italy achieved an average annual growth rate of 3.0%, Germany 2.8% and France 2.4%. As a result, there was significant convergence of the per capita GDP of the major European economies, and convergence between Europe and the USA. The average annual growth rate of per capita income in Japan was 4.1% in the same period, significantly higher than in the USA and the major European economies. However, even during the past 60 years, the less developed economies have not demonstrated a uniform tendency towards convergence with the per capita income of the developed economies. Some developing economies, par:cularly in the rest of Western Europe and Southeast Asia, have achieved impressive increases in per capita income compared to 1950, and significant convergence with the living standards of the developed economies. However, other economies, par:cularly in La:n America, the rest of Asia and Africa, have fallen drama:cally behind. 16

17 Economic Growth in the European Periphery and Southeast Asia It is worth no:ng that with an average growth rate of 3%, per capita GDP doubles every 23 years. Thus, between 1960 and 2010 per capita GDP in Greece has increased by about 4.5 :mes (average growth rate of 3%), and from 36.3% of US per capita GDP in 1960 it reached 61% in Similar increases in per capita GDP were experienced by other economies of the European periphery such as Spain, Portugal and Ireland. From the rest of the world what stands out is the spectacular postwar growth performance of Asian economies, especially in South East Asia. Except from Japan (average growth rate of 3.4% per year), China (4.6%) and India (3.1%), which have a high rate of convergence in recent years, the ones that stand out are Korea (5.6% growth), Taiwan (5.7%), Singapore (5.1%) and Hong Kong (5.0%). Malaysia (4.2%) and Thailand (4.3%) did not lag far behind. The impressive growth performance of these economies have given them the nickname "Asian :gers". The long-term growth performance and other Asian economies is also posi:ve and not significantly inferior to the performance of the economies of the European periphery. 17

18 The Disappoin:ng Growth Performance of La:n America and Africa The growth performance of La:n American economies lag behind the respec:ve performance of the Asian economies. A typical example is Argen:na. Its per capita GDP dropped from 39.2% of that of the US in 1960, to 29.8% in Due to the low growth rate (1.4% per year), instead of convergence there was divergence. Similar developments occurred in economies such as Mexico, Colombia, Venezuela, Paraguay and Peru. The only La:n American economies that seem to have escaped from the norm are Brazil and Chile, which have displayed convergence with the per capita GDP of developed economies. However, this convergence was not par:cularly fast. The situa:on in Africa is even worse, par:cularly in sub-saharan Africa. Egypt and Morocco displayed convergence similar to that of the economies of the European periphery, but started from a very low level. Their respec:ve per capita GDP in 2010 was 12% and 9% of that of the US. South Africa has had a similar growth performance to Argen:na. But economies like Kenya, Nigeria and Zimbabwe are stuck in so called poverty traps, with per capita GDPs in 2010 that ranged from 0.8% to 4.1% of that of the US, much lower than in

19 The Solow Model The point of departure in the theory of economic growth is the model of Solow (1956). The model is essen:ally a closed economy model, based on a neoclassical produc:on func:on and the assump:on of a constant (exogenous) savings rate. Given that in a closed economy savings is equal to investment, the process of capital accumula:on posi:vely depends on the savings rate. The accumula:on of capital per worker con:nues un:l the savings per employee are equal to deprecia:on and addi:onal investments required to maintain a constant capital/labor ra:o. Καθ. Γ. Αλογοσκούφης, Δυναμική Μακροοικονομική 19

20 Exogenous Technical Progress When there is exogenous technical progress that increases the efficiency of labor, the economy converges to a constant ra:o of capital to labor, augmented by technical progress. In the long-run equilibrium of this model, usually referred to a the steady state or the balanced growth path, economic growth is exogenous and is equal to the rate of popula:on growth plus the rate of technical progress. Per capita product and income grow at the exogenous rate of technical progress. This model provides for convergence of per capita incomes to a steady state per capita income that depends on the structural characteris:cs of each economy, such as total factor produc:vity (produc:on efficiency), popula:on growth, and the savings and investment rate. 20

21 Proper:es of the Solow Model The Solow determines the dynamic path of total output, (Υ), consump:on (C), the capital stock (K), real wages (w) and the real interest rate (r). The number of employees (L), the efficiency of labor (h), the rate of popula:on growth (n) and the rate of technical progress (g) are assumed exogenous. Total factor produc:vity (A), the savings rate (s) and the deprecia:on rate of capital (δ) are also assumed exogenous. Thus, the model explains the dynamic path of the endogenous variables as func:ons of all the exogenous variables. In fact, all the endogenous variables turn out to be func:ons of capital per efficiency unit of labor. 21

22 The Produc:on Func:on The produc:on func:on of the representa:ve firm depends on capital and labor. It is assumed that the marginal products of capital and labor are posi:ve and declining, and that there are constant returns to scale. A special form of the neoclassical produc:on func:on is the Cobb Douglas produc:on func:on, of the form, Y t = AK t α (h t L t ) 1 α where Υ is total real output, K the capital stock, L the number of employees, h the efficiency of labor, and A a parameter measuring the efficiency of produc:on (total factor produc:vity). α measures the rela:ve contribu:on of capital in produc:on, and t is a discrete :me index. All endogenous variables are func:ons of :me. 22

23 Popula:on Growth and Technical Progress As already men:oned, in this model the rate of popula:on growth n and the rate of technical progress g are considered exogenous. As a result, we assume that, L t = L 0 (1+ n) t h t = h 0 (1+ g) t where L 0 is the ini:al level of popula:on (at t equal to zero) and h 0 the ini:al level of the efficiency of labor. 23

24 Constant Returns to Scale The produc:on func:on is characterized by constant returns to scale. Mul:plica:on of the factors of produc:on by any real number mul:plies total output by the same number. If you double the quan:ty of inputs, then total produc:on is doubled too. If you triple the quan:ty of inputs, then total produc:on is tripled too. Because of constant returns to scale, the produc:on func:on can be wrijen as, y t = Ak t α where, y = Y/hL k = K/hL output per efficiency unit of labor capital per efficiency unit of labor 24

25 Savings, Investment and the Accumula:on of Capital Solow assumed that the savings rate is a constant ra:o of the disposable income of consumers. Therefore, aggregate consump:on is determined by, C t = (1 s)y t = (1 s)ak t α (h t L t ) 1 α From the na:onal income iden::es, total output is equal to consump:on plus investment. Thus, Y t = C t + I t = (1 s)y t + K t+1 K t + δ K t where δ is the deprecia:on rate of capital. Solving for capital accumula:on. K t+1 K t = sy t δ K t = sak t α (h t L t ) 1 α δ K t 25

26 Capital Accumula:on per Efficiency Unit of Labor Expressing the equa:on for capital accumula:on it terms of efficiency units of labor, i.e dividing by hl, we get, k t+1 = 1 (1+ n)(1+ g) sak α t + (1 δ )k t ( ) This is the basic equa:on for the accumula:on of capital per efficiency unit of labor in the Solow model. Insofar as savings per efficiency unit of labor exceed the investment required for the amor:za:on of capital, popula:on growth and technical progress, capital per efficiency unit of labor increases. 26

27 Convergence and the Balanced Growth Path in the Solow Model 27

28 The Balanced Growth Path in the Solow Model From the accumula:on equa:on, capital per efficiency unit of labor converges to a constant level where k t+1 =k t =k*. From the produc:on func:on y t =Ak t α, the same applies for output per efficiency unit of labor, which converges to y t+1 =y t =y*. These constants are defined by, k* = sa (1+ n)(1+ g) (1 δ ) 1 1 α y* = A sa (1+ n)(1+ g) (1 δ ) α 1 α Per capita income along the balanced growth path grows at a rate g and is determined by, Y t = y *h t = A L t sa (1+ n)(1+ g) (1 δ ) α 1 α h0 (1+ g) t 28

29 Total Factor Produc:vity and Per Capita Income This model predicts that the higher is total factor produc:vity, i.e the efficiency of the produc:on process, A, the higher the per capita income of an economy on the balanced growth path. One reason, is that for given capital and labor more output is produced. A second reason is that with greater efficiency in the produc:on process, the capital stock turns out to be higher, because higher output implies higher savings. More efficient economies accumulate more capital in the Solow model. 29

30 Total Factor Produc:vity and the Capital Stock 30

31 The Savings (Investment) Rate and Per Capita Income This model predicts that the higher the savings (and investment) rate s, the higher the per capita income in the balanced growth path. The reason is that a higher savings rate can finance a higher equilibrium investment rate on the balanced growth path, which results in a higher accumula:on of capital and higher income. 31

32 The Savings Rate and the Capital Stock 32

33 The Effects of Popula:on Growth, Technical Progress and Deprecia:on of Capital on Per Capita Income The Solow model predicts that the higher these parameters are, the lower the capital stock and realincome per efficiency unit of labor efficiency. The reason is that, given the savings rate, equilibrium investment can sustain a lower capital stock the higher these parameters are. Consequently, the capital stock per efficiency unit of labor and income will have to go down. 33

34 The Convergence Process in the Solow Model The Solow model predicts that an economy converges to the balanced growth path regardless of the star:ng point. The ques:on is what determines the speed of convergence. It is important to be able to calculate this speed because it determines how fast developing economies can achieve the highest possible standard of living given their structural characteris:cs. If we linearize the accumula:on equa:on around the balanced growth path, we have that, k t+1! k *+λ(k t k*) λ = α + (1 α )(1 δ ) (1+ n)(1+ g) This difference equa:on indicates that in each period the difference of the capital stock from the one corresponding to the balanced growth path is a propor:on λ of the difference that existed in the previous period. Accordingly, the adjustment speed is given by 1-λ. 34

35 Calcula:ng the Convergence Speed in the Solow Model The general solu:on of the linearized difference equa:on that describes the convergence process in the Solow model takes the form, k t+1 = k *+(k 0 k*)λ t This solu:on can be used to calculate how many years will be needed to cover a certain percentage of an ini:al difference θ of the capital stock of an economy from that corresponding to the path of balanced growth. (1 θ) = k t+1 k * k 0 k * = λ t 35

36 The Speed of Convergence in the Solow Model and the Time Required to Close the Gap from the Balanced Growth Path t = ln(1 θ) ln(λ) Assuming that α=0.33, δ=0.03 (3% per annum), n=0.01 (1% annum) και g=0.02 (2% per annum), then it follows that λ=0.96. The speed of convergence 1-λ in this case is equal to 0.04, or 4% per annum. As a result, in order to cover two thirds of an ini:al difference from the balanced growth path, (θ=2/3), with the assump:ons we made (λ=0,96), the :me required is 27 years (ln(1/3)/ln(0.96)=26.9). In order to cover half of the difference (θ=1/2) the :me required is roughly 17 years. In order to cover 90% (θ=1/10) the :me required is roughly 56 years. 36

37 Differences in the per Capita Income of Countries and the Solow Model To explain differences in the per capita income between countries the Solow model is based on two sets of factors. First, the differences in the parameters that determine per capita income in the balanced growth path, and, secondly, the differences in the ini:al condi:ons of the various countries regarding the capital stock. Assuming two economies where the rate of popula:on growth n, the rate of technical progress g, and the deprecia:on rate δ are the same, the ra:o of their per capita incomes is determined by, y = A h 1 01 s 1 A 1 12 A 2 h 02 s 2 A 2 α 1 α 37

38 Explaining Differences in the per Capita Incomes of Countries Differences in the savings and investment rate s: If for example economy 1 has a savings (investment) rate of 25%, and economy 2 a rate of 12.5%, assuming a = 0.33, the ra:o of their per capita income would be 1.4 to 1 on the balanced growth path. Both economies will converge, but to different levels of per capita income. Economy 1 will have a per capita income 40% higher, even acer the convergence of each economy has been achieved. Differences in Total Factor Produc'vity (efficiency of produc'on) A: If economy 1 is twice as efficient in the produc:on process as economy 2, then the ra:o of their per capita incomes will be 2.8 to 1 on the balanced growth path. Economy 1 not only produces twice more for a a given capital stock, but will also end up with 1.4 :mes more capital per worker than economy 2. Differences in the Ini'al Efficiency of Labor h: These are translated one to one in differences in per capita income. If the ini:al efficiency of labor in economy 1 is double that of economy two, then the per capita income of economy 1 on the balanced growth will be double the per capita income of economy 2. These differences can only be addressed if economy 2 engages in higher educa:on and training of its workforce to achieve a higher growth rate of labor efficiency than the exogenous rate of technical progress. Differences in Ini'al Condi'ons: If economy 1 starts with triple capital per worker from economy 2 economy 1 will ini:ally have a 40% higher per capita income than economy 2, even in the case where the two economies eventually converge to the same per capita income in the balanced growth path. To close 90% of the difference in per capita income, under the assump:ons we made above, it would take 56 years of convergence. 38

39 Conclusions from the Solow Model This model can at a first level explain both long, and short-term differences in per capita incomes of the countries that make up the global economy. It can explain the simultaneous existence of developed, emerging and developing economies, and the differences in their living standards. It emphasizes factors such as the efficiency of the produc:on process (total factor produc:vity), the efficiency of labor (human capital), the savings and investment rates and other factors such as the popula:on growth rate. Moreover, it emphasizes the different ini:al condi:ons with respect to the available capital in different economies, and predicts a condi:onal convergence process. 39

40 Weaknesses of the Solow Model On the other hand, this model has three major weaknesses. The first is that it is mainly based on physical capital accumula:on as the main factor in explaining the differences in living standards of different economies. However, physical capital accumula:on is not sufficient to explain the large differences in per capita income between the economies nor the rela:vely slow process of convergence. The second weakness is the assump:on that the savings rate and investment is exogenous. Finally, a third theore:cal weakness is that it assumes that domes:c savings equal to investment, without being able to explain inter-temporal trade, interna:onal capital movements and the role of external imbalances in open economies. All three of these weaknesses have to some extent been addressed by extended models, which do not overturn the basic predic:ons of the Solow model about the role of investment, produc:on efficiency, produc:vity of labor and of ini:al condi:ons in the process of economic growth. 40

41 The Solow Model, the Interna:onal Borrowing and Lending and External Debt Crises Because many developing economies are characterized by significant investment opportuni:es but low domes:c savings, there is a tendency for them to have deficits in their current account and borrow from developed economies. As a majer of principle, lending produces benefits for both the developing and the developed economies. However, the excessive interna:onal borrowing in foreign currency from emerging economies ocen leads to their inability to service their external debt if interna:onal economic condi:ons turn for the worse. These debt crises ocen cause currency and banking crises that have adversely affected both them and the global economy. This is an issue upon which we need to focus our ajen:on. 41